Lessons from Macondo

Experts from global professional services firm PriceWaterhouseCoopers and international law firm Clyde & Co alerted NOCs and operators from the UAE to the legal and financial repercussions the Deepwater Horizon oil rig explosion and subsequent oil spill has for offshore projects in the region.

Jesus Aleman, PwC Partner for Energy, Utilities and Mining in Abu Dhabi, provided an over view of the Macondo disaster and ensuing spill, tracking the financial implications for BP and its shareholders as events unfolded.

Aleman estimates that the fallout from Macondo saw overall operational costs for offshore projects in 2011 rise by 11%. He predicts costs will be to 16% higher in 2012 as a result of the spill.

Contracts

George Booth, Energy Partner at Clyde & Co, Abu Dhabi, set the scene with a refresher on the regulatory environment for offshore projects in the UAE (see page 24), before explaining how the Macondo fallout affects relationships between operators and contractors.

At the heart of the relationship between operators, partners and contractors is a contract.

“The industry has been moving towards contract standardisation for years, and contract officers and lawyers have been used to using standard form agreements,” said Booth. He queries whether these agreements are now fit for purpose.

Booth explained that, as is standard, BP accepted no contractual liability for the operations at Macondo, except in the event of “gross negligence or willful misconduct”. Instead, non-operator partners bear liability.

Following the blowout, Anadarko, one such BP partner, is currently refusing to pay its 25% share for costs relating to the disaster and accuses BP of both failings.

Proof of BP’s gross negligence and/or wilful misconduct is the only way Anadarko can escape its obligation to pay BP for 25% of the liabilities arising from the disaster: Aleman said Anadarko’s existence may hang on whether they win or lose in court.

“Us lawyers and contract operators have been very comfortable using terms like ‘gross negligence’ and ‘willful misconduct’ in the past, as they have been defined by courts of law and by lawyers in ivory towers in the City of London,” said Booth.

“There has not been sufficient discussion of what they actually mean, and how they might affect a very complex industry,” Booth said. “We can no longer just rely on these kinds of terms”.

Booth also raised the conundrum of seconded workers between between operators and contractors.

If a joint venture partner seconds an engineer to an operator, and that secondee commits gross negligence or willful misconduct, is the JV partner able to back out from contributing for loss, on the basis that is was caused by something excluded under the terms of the joint operation agreement (JOA)? Booth says Macondo means these kinds of issues need to be resolved.

Another common contractual provision is the operator’s right to make cash calls on non-operator partners for addition expenses. Currently, most JOAs preclude a contractor from disputing whether they should pay, on pain of serious penalties.

“Macondo has brought this to head,” says Booth. “In a catastrophic situation, which is very complicated, and where liability is disputed, is it really acceptable that the operator can make cash calls against JV partners with the threat of draconian
penalties?”

Booth said that operators and contractors should now expect to see a lot more pre-contractual negotiations on clean-up liabilities. “In recent auctions of deep water field off Iceland, the government sought a $2 billion bond in respect of clean-up from operators,” he said.

Such barriers to competition by governments are likely to squeeze smaller oil companies from the market, Booth says.

“More generally, governments and regulators are going to ensure that potential liability falling on the operator if something goes wrong is going to increase,” says Booth. “Operators are going to try to push these liabilities down the contractual chain”.

Booth queried whether operators should continue to work on no-profit, no-risk basis, or whether a shared-risk model may now be preferable in light of the kinds of potential liabilities seen in the Gulf of Mexico.

The insurance landscape would have to change significantly and operators are likely to think much harder about what to take on.

Insurance

Wayne Jones, Commercial Litigation and Insurance Partner at Clyde & Co, Dubai, explored how Macondo throws local insurance arrangements into relief, what problems might be out there, and how they can be fixed.

“Insurance tends to be seen as the deep pocket, the thing that covers everything,” said Jones. “However, in the case of Macondo, BP’s third party claims (by fishermen, etc) is slated to be in the range of $1.2 to 1.5 billion, whereas typical insurance policies cover third party losses up to $100 million: quite a difference”.

Jones sees this a real challenge for regional operators and contractors, as insurers are unlikely to increase these limits.

“GCC insurance policies typically have an all-in liability of $1 billion,” Jones explained.

“Yet the total bill for the Macondo disaster is estimated to be between $35 billion and $70 billion”.

With total insurance cover for all the parties involved in the offshore well totaling only $3-6 billion, “insurance is not going to soak up everything; there is more that people need to do,” Jones says.

If the cost of an accident is greater than the insurance cover in place, after the insurance payouts comes the threat of litigation. Jones predicts the litigation resulting from the Gulf of Mexico spill is going to continue for years.

“The Exxon Valdez litigation took 19 years to conclude,” says Jones, and “in March BP’s lawyers had their authorized monthly legal spend increased from $850,000 to $1.25 million; a serious amount of cash over that sort of period on legal fees”.

The coverage limit of GCC insurance policies is not the only challenge for regional players.

“A typical GCC policy covers everything from claims from a wide range of parties including suppliers and financiers to environmental penalties, problems with well control, operator’s additional expenses, contractual liability and clean-up costs,” say Jones. “It’s just a contract for indemnity up to a particular limit, subject to particular rights and duties”.

“Insurance cover can therefore start inadvertently covering things that were never intended to be covered, because those risks have been dealt with through contractual provisions,” says Jones. The risk is that contractual disputes are paid out of insurance money needed for priority liabilities, such as injury payments and government fines.

Jones wryly pointed out that ”the other limitation with insurance is that it doesn’t get you out of prison. If you have a health and safety inspector on a rig when it blows up, then no amount of insurance is going to keep you from going to prison”. It also does not cover reputational damage – which BP suffered – and typically will not cover full cost.

So what can operators and contractors do? The first, says Jones is to assess your risk and ensure you understand what it is and where it is. “This obviously includes physical risk, and the risk posed by the work itself,” says Jones.

“The second type of is risk is posed by contracts. Are contracts whose principles have been tested in western jurisdictions and courts fit for civil jurisdictions?” Jones recommends operators have their contracts ‘stress-tested,’ as terms used in long-standing standard forms may no longer be appropriate.

“Operators and contractors also need to ensure they are not operating in silos: that one team is looking at contracts, one is looking at risk management, and yet other is looking at insurance coverage,” says Jones, in case there are unwelcome overlaps or holes between these groups.

Firms can undertake an evaluation of their current insurance coverage, and should ensure valuations of their assets are up to date. Additionally, conducting warranty surveys and independent reports from independent experts on assets can save a lot of money if litigation beckons.

Letter of the Law: UAE

George Booth of Clyde & Co gives the law for offshore in a nutshell

– There are two overarching pieces of federal legislation affecting every firm in the UAE: the Labour Law of 1980; and the Environmental Protection Act 1999.

– The Labour Law imposes a duty on all employers to protect employees by ensuring safe systems of work. If an employee is injured, the employer may face a fine, and will have obligations to pay for medical treatment and wages for a period. The Islamic principle of Diyya – blood money – applies for the benefit of relatives in event of a fatality.

– Everyone needs to keep up to date Health & Safety records of procedures and incidents: these will be disclosable to authorities and courts, so do them right.

– Each firm needs to have a Health & Safety framework that has not only been read and understood by all employees, but is also intrinsic within the nature of the organisation.

– The cost of any environmental cleanup under federal law is likely to be very high. Its root in the transactional civil law principle of making good any harm done. There can be criminal penalties in extreme circumstances. People need to be adequately trained in order to ensure a firm discharges its environmental responsibilities.

– The body with ultimate responsibility under federal law is different in each emirate: in Abu Dhabi, it is ADNOC; in Dubai, it is the Dubai Municipality.

– ADNOC is – generally-speaking – the regulator, verifier, judge and enforcer in respect of Health and Safety.

– ADNOC has a code of practice (COPs) for each aspect of oil & gas work, from drilling to handling hazardous materials and waste management. They are comprehensive and must be followed on any offshore operation. You will not get a No Objection Letter from ADNOC without proving you can meet their standards. Be aware of differences in COPs between the Emirates.

– It is not enough to simply follow the letter of the COPs. Judges and regulators expect to see compliance with whatever best meets international standards of best practice.